This blog by a tax professor is about tax reform and moving tax systems into the 21st century. It focuses on tax system weaknesses, critiques selected reform proposals, and offers new ideas, with an emphasis on federal, California and multistate matters. Additional information - articles, reports and links, can be found at the 21st Century Taxation website (see link below right). I welcome your comments.

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Wednesday, December 28, 2011

Tax Complexity Due to Multiple Provisions and Future Benefits

This morning I was looking at a tax update presentation of mine from May 2010 to get some information on the enactment of the FATCA (Foreign Account Tax Compliance Act) provisions that were added by the HIRE Act (Hiring Incentives to Restore Employment Act (HIRE) (P.L. 111-147; 3/18/10)). I was reminded of a part of the HIRE Act that won't provide a benefit until employers file their 2011 income tax forms. The key part of the HIRE Act was a temporary payroll tax exemption for employers who hired an unemployed worker in 2010. If that worker is employed a consecutive 52 weeks and his/her wages for the second 26 consecutive weeks equaled at least 80% of his/her wages for the first 26 consecutive weeks, the employer can claim a $1,000 income tax credit. This is an all-or-nothing credit. That is, if the worker was employed only 51 weeks, no income tax credit. The credit is claimed on Form 5884-B, New Hire Retention Credit.

Sources of complexity described above:

Will employers remember to claim the $1,000 income tax credit? This ties to a provision enacted in 2010 which provided a payroll tax exemption in 2010. The income tax benefit can't come until 2011 (an eligible worker was one hired after 2/3/10, so can't have 52 weeks continuous employment until 2011).

Will employer income tax records have the necessary data? The original tax benefit is in payroll records, the 2011 income tax credit needs to pull that payroll information into the income tax calculations. There is a reminder on Form 3800, General Business Credit, in that line "aa" lists the worker retention credit (it is line "aa" because a - z are already taken with other business credits! (another source of complexity in the law - too many special provisions)).

Will the tax prep software help? Probably. Many of the problems of complexity are lessened (but certainly not excused) through good tax prep software. To be sure eligible employers claim the worker retention credit in 2011, their tax prep software should ask a question about it to reminder the employers to pull this data out of their HR and payroll records.

The worker retention credit is not the only tax benefit that spans a few years. Another one is Section 1202 that provides a tax break to non-corporate shareholders who have "qualified small business stock" (QSBS). The general rule provides that if the QSBS stock is held over five years and sold at a gain, 50% of the gain is not taxable for regular tax purposes. As part of a few economic stimulus provisions enacted in 2009 and 2010, this percentage was changed to 75% and then to 100% (for stock purchased before 1/1/12). The tax benefit won't come until over five years from the purchase date. Again, tax prep software will help by asking the questions - is the stock sold QSBS and when was it acquired?

Complexity problems:

Having to maintain records over a span of years to be sure the tax benefits are obtained.

Mixing of different records such as the payroll/HR records for an income tax benefit.

Varying effective dates. For example, the dates for the payroll tax exemption are not identical to the dates to qualify for the retention income tax credit. Also, the QSBS benefit is either 50%, 75% or 100% depending on when the QSBS was acquired.

Funding short-term tax breaks with permanent provisions, such as was done with the payroll exemption and retention credit funded by FATCA which is a permanent provision in the law. The complexity lasts beyond a temporary time period.

Solutions:

Only enact temporary tax provisions for a really good reason (such as to stimulate the economy and avoid a longer recession).

Avoid multiple possible solutions such as was done with the various economic stimulus provisions. Identify two or three best stimulus provisions and enact them and no others.

Pay for temporary tax provisions with temporary tax increases that are as simple as possible such as ones that do not add new rules, but modify existing ones.

Have provisions last an entire tax year, such as by having the effective date be for the tax year starting on or after 1/1/11.

1 comment:

You have raised very valid concerns. What also Congress should have considered enacting the HIRE Act was how much it would cost a business to claim a new hire retention credit in time spent in internal record keeping as well as CPA time in interviewing and collecting pertinent data. In some cases, the benefit is too low compared to the cost.

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The world is changing yet tax systems have been slow to change in the same direction. This can hinder economic progress, lead to a loss in tax revenue, and frustrate taxpayers. Here, I explain some of the problems at the federal, multistate and California levels, offer ideas for reform, and an opportunity to comment on what I post. These views are my own and not necessarily those of my employer or any organization I'm connected with. Thanks for reading and posting comments (this page gets over 8,000 visits per month)! For more on tax reform, please visit http://www.21stcenturytaxation.com. You can reach me at annette.nellen@sjsu.edu.

Annette Nellen

Professor Annette Nellen

About Me

I am a tax professor and Director of the MS Taxation Program at San Jose State University. I teach courses on tax research, tax accounting methods, taxation of property transactions, state taxation, ethics, and tax policy. I am active in the tax sections of the AICPA, ABA and CA Bar. I currently serve on the AICPA Tax Executive Committee (chair) and Tax Reform Task Force. I am a past chair of the AICPA Individual Taxation Technical Resource Panel and a past vice chair of the Executive Committee of the California Bar Tax Section. At SJSU I chair the Athletics Board and serve on the WASC accreditation steering committee. I welcome your comments to my blog posts.